Eurozone: Sticking plaster, not cure

Chancellor Merkel and President Sarkozy Image copyright Getty Images
Image caption President Sarkozy visited Chancellor Merkel in Berlin recently to discuss the crisis

Something slightly odd is going on.

Markets are behaving as though European governments will definitely agree a rescue package for the eurozone next weekend and that the rescue package will sort all Europe's financial and economic woes.

But, by contrast, when I talk to ministers, regulators, bankers and investors they all say - which is a statement of the obvious - two things: that such a rescue cannot be taken for granted; and (perhaps more importantly) that whatever is agreed will not solve the eurozone's fundamental problem.

What they broadly mean by all of that is that any agreement to strengthen Europe's banks (and see my note of last Thursday for detail on the planned emergency measures) treats the symptoms of the disease, not the disease itself.

Or to put it another way, it is all very well to strengthen banks so that they have enough capital to absorb whatever losses may come their way in the event that Greece, Italy, Spain, Portugal and Ireland can't repay their debts.

To state the bloomingly, bleedingly obvious, a domino effect of collapsing banks, triggered by their inability to borrow because of creditors' fears that the banks could not withstand sovereign defaults, would be the kind of Armageddon that would obviously be better averted.

But if that's the symptom that needs immediate treatment, the disease is that those eurozone countries with huge debts and deficits are struggling to strengthen their own respective balance sheets.

In that context, it is probably not helpful that there is a disagreement between eurozone governments - between France and Germany for example - about how much to write down what the Greek government owes. And there is a similar dispute within the private sector about both the scale and nature of any reduction in what Greece has to repay.

Restoring confidence

Because it is impossible to reach any consensus on Greece - even though it is the most egregious example of a country trapped in a debt-induced vicious cycle of fiscal crisis inducing economic contraction that in turn worsens the fiscal crisis - there is no proper debate at all about whether there should be orderly reductions in the debts of other eurozone members.

And, before you ask, the alternative strategy, of stimulating growth in these countries, so that they use the proceeds of growth to pay down debt, has already been dismissed (rightly or wrongly) as unworkable.

Instead, eurozone governments are placing all their faith in what's known as liquidity support, of providing emergency loans to the likes of Italy to tide those countries over - which is another way of saying that eurozone governments see investors' lack of confidence in Italy's and Spain's ability to repay their debts as wrong, and that one day soon investors will come to their senses.

So the other pillar of the putatively comprehensive eurozone rescue plan to be unveiled at next weekend's summit would be an expansion of the firepower of the bailout fund, the European Financial Stability Facility, from €440bn to €2trn of €3trn.

But even if a policy of buying Italian and Spanish government bonds (sovereign debt) that commercial investors don't want were to be sensible, even if that could provide adequate time to Italy and Spain to demonstrate to the world that they are balancing their books and re-engineering their economies away from borrowing-fuelled growth and public-sector spending, there is a technical problem.

It is not clear how the firepower of the bailout fund is to be increased.

What's more, any increase in its firepower will involve the stronger eurozone countries that underwrite the EFSF, especially Germany, taking considerable risks - and those risks may not be welcomed by the taxpayers of the stronger countries (pretty much all ideas for giving the EFSF adequate resources would see it first in line for losses were a country like Italy ultimately to default).

All of which is to say that anyone who believes that we may be approaching the end of the eurozone's wobbles and agonies is guaranteed to be disappointed, and quite soon.